India’s slowing inflation to give RBI room to pause on interest rates

RBI expects inflation to reach 5.1-5.6% in the first half of the financial year starting 1 April, before easing in the second half. Photo: Bloomberg

Mumbai: Inflation in India slowed for a second straight month, giving the Reserve Bank of India (RBI) room to keep interest rates on hold for longer while providing relief to battered bond investors.

Government data on Monday showed inflation rose 4.44% in February from a year ago, lower than the 5.07% rise in January. Economists polled by Bloomberg News had expected an annual reading of 4.7%. The drop below 5% for the first time in three months will give bond investors—many of whom are state-run banks and who are staring at losses of $3 billion—something of a temporary cheer.

“We see the RBI on a long pause,” said Indranil Pan, chief economist at IDFC Bank in Mumbai. “Some uptick can happen, however, we do not see the risk of inflation going beyond 6%.”

Most analysts and RBI itself expect inflationary pressures to gather steam in coming months. The central bank expects inflation to reach 5.1-5.6% in the first half of the financial year starting 1 April, before easing in the second half. The RBI targets inflation over the medium term at 4% with an upper limit of 6% and a lower threshold of 2%.

Last month, one member of the six-member monetary policy committee voted for a rate hike, another gave up his call for rate cuts while deputy governor in charge of monetary policy, Viral Acharya, also veered more toward the hawkish camp. The rest, for now, appeared neutral. Still, the MPC voted to keep rates unchanged at its last meeting and flagged the government’s decision to widen budget deficit targets as something that will have an inflationary impact.

“RBI will have room to push back a rate hike, but not for too long as input price pressures have been on the rise over the past one year, and price pass-through to consumers is now taking place,” said Teresa John, economist at Nirmal Bang Pvt. Equities Ltd.

Analysts expect food inflation to rise because of the seasonal upturn in vegetable prices in the summer, an increase in minimum support price of summer crops that will reflect with a lag, and an upswing in global wheat prices. Moreover, core inflation is sticky at around 5%, while an imposition of more tariffs on some imports like mobile phones is likely to boost price pressures, giving the RBI more ammunition to wait and watch.

Separate data showed industrial production rose 7.5% in January, handily beating estimates of a 6.4% rise and a growth of 7.1% in December. Also, private sector data showed local passenger vehicle sales grew 7.8% in February from a year ago, highlighting steady demand in the Indian economy.

Nevertheless, the recovery from demonetisation and the chaotic introduction of the goods and services tax (GST) last year has been uneven. India’s dominant services sector contracted in February, with scandals hitting the corporate and banking sectors and weighing on business sentiment.

RBI expects economic growth to pick up in the next financial year. It expects gross value added—a key measure of growth—to increase 7.2% next fiscal year from 6.6% this year. Bloomberg